Shopify: The Sin of Overvaluation - Is Mediocrity Unacceptable?

On the evening of February 11, Beijing time, before the U.S. stock market opened, the leading independent e-commerce company in the U.S., $Shopify (SHOP.US), announced its Q4 2024 financial report. In summary, the overall performance was quite good, with the core indicators GMV and GPV continuing to show a good trend of accelerating growth quarter-on-quarter. Total revenue, gross profit, expenses, cash flow profit, and other indicators also exceeded expectations. However, high valuations correspond to higher expectations, with detailed points as follows:

1. Key operational indicators -- this quarter, Shopify facilitated a total GMV of $94.5 billion, a year-on-year increase of 25.7%, accelerating by about 1.7 percentage points compared to the previous quarter, and also higher than the sell-side consensus expectation of about 24% growth. The core indicator has shown accelerated GMV growth for two consecutive quarters, reflecting the strong growth momentum of Shopify's business remains unchanged.

However, under high valuations, the expectations from funds are actually higher. It is reported that the buy-side expectation for this quarter's GMV growth is between 25% and 26%, so this quarter's performance is more in line with or slightly under the expectations of more optimistic investors.

2. Due to the impact of PayPal's confirmation of changes in accounting standards: from originally being considered a third-party payment channel, it has changed to being considered a first-party, therefore payments completed by merchants on Shopify through PayPal will be fully accounted for in GPV and merchant service revenue. It is estimated that this change in accounting standards has a positive impact of about 300 basis points on the ratio of GPV / GMV.

This quarter, the GPV amount was $60.7 billion, a year-on-year increase of 34.7%, which is 3.3% higher than market expectations. Shopify's payment penetration rate (i.e., GPV / GMV) reached 64.3%, an increase of about 280 basis points quarter-on-quarter, generally in line with the above estimates.

3. In terms of revenue, merchant services revenue this quarter was $2.15 billion, with a year-on-year growth rate jumping to 31.2%, significantly outperforming the market expectation of 27.4%. However, as mentioned above, in addition to strong GMV growth, a considerable part of this is due to the impact of the change in revenue recognition from the PayPal channel. Correspondingly, this quarter, the monetization rate of merchant services (the proportion of GMV) increased by 11 basis points year-on-year.

Subscription service revenue was $670 million, a year-on-year increase of 26.9%, higher than the market expectation of 24.2%. Unlike the MRR indicator, the growth of subscription service revenue did not slow down quarter-on-quarter. However, since MRR is a relatively leading indicator, next quarter's subscription revenue may experience a slowdown in growth.

4. From the perspective of gross profit, the change in revenue recognition from the PayPal channel has a negative impact on gross margin. Therefore, the gross margin of the merchant services business decreased by about 1 percentage point year-on-year this quarter, but the extent of the decline is consistent with market expectations and is not unexpected bad news. However, the gross margin of subscription service revenue also decreased by about 2 percentage points year-on-year, which was unexpected. Combined with the MRR indicator, which also fell short of expectations, we suspect that the company may have offered some price discounts, and the actual situation needs to be clarified by management.

5. From the expense perspective, this quarter Shopify's total operating expenses amounted to approximately $890 million, accounting for about 32% of revenue, which is at the lower end of the company's guidance of 32% to 33%, and is generally in line with market expectations. Compared to last year, the expense-to-revenue ratio decreased by about 4 percentage points year-on-year.

Among them, the contribution of marketing expenses was the most significant, with only a 9.8% year-on-year increase, far below the revenue growth rate. This alone saved a profit margin of 2.4 percentage points year-on-year. R&D expenses and administrative expenses also only grew by 12% to 13%, which is also significantly lower than the revenue growth. Despite strong growth, the company's expenses continue to be subject to overall passive dilution.

6. Due to the strong growth of the underlying core indicators GMV & GPV (although MRR has weakened, it has not yet reflected in revenue), and the ongoing "passive" dilution of expenses, although the gross margin has unexpectedly declined, overall, Shopify's profits are still in a cycle of improvement.

This quarter, the core operating profit margin (excluding only the usual three expenses, not deducting loan losses, etc.) increased by 3.6 percentage points year-on-year to 19.2%, continuing to set a historical high, exceeding the market expectation of 17.9%. The company's more focused free cash profit reached $610 million this quarter, also exceeding market expectations by about 7%. The cash profit margin was 21.7%, better than the company's guidance of a year-on-year flat profit margin (about 20.8%).

7. Regarding guidance for the next quarter, in terms of revenue, Shopify guides revenue growth to be in the mid-twenties, with a decline in growth rate (1Q is a low season and there are negative impacts from TikTok regulation), but the market expectation of 24.8% is basically in line. In terms of gross profit, the guidance for gross profit year-on-year growth is in the low-twenties, which is also generally in line with the market expectation of 23.8%.

In terms of expenses, the guidance for the expense-to-revenue ratio is only 41% to 42%, consistent with market expectations and a significant improvement from 47% in the same period last year; in terms of profit, the guidance for FCF as a percentage of revenue is in the mid-teens, which, although expanded compared to 12% in the same period last year, missed the market expectation of 17.3%. The FCF margin falling short of expectations is one of the most significant drawbacks of this business.

Dolphin Investment Research Opinion:

As mentioned earlier, looking solely at Shopify's performance this quarter, it can be said that the advantages outweigh the flaws, and overall it can be considered good. However, the biggest original sin is the company's excessively high valuation, with the pre-earnings market value corresponding to a 25-year revenue expectation of about 15x P/S Such a level of valuation is considered high even among SaaS stocks. A high valuation implies high expectations; without a significantly better-than-expected performance, it may not be enough to drive the stock price further up. The market's fluctuating stock price after the earnings report reflects the struggle between decent performance and high valuation.

Looking at the two business segments separately, the still strong and accelerating growth of GMV & GPV, combined with the benefits brought by the partnership with PayPal, suggests that the outlook for merchant service revenue, primarily from payment income, should still be decent. However, the slowing growth of MRR and the unexpectedly declining gross margin of subscription revenue may indicate some concerns about the outlook for subscription income.

The only cash flow profit margin that fell below expectations in the guidance, combined with the management's clear statement during the conference call that the company's profit margin has significantly improved in fiscal year 2024, reaching a level satisfactory to management, indicates that management does not intend to pursue profit margin expansion in 2025. Instead, they will focus more on growth opportunities in the trade-off between growth and profit margin. This may lead the market to believe that the company will increase investment, causing a (temporary) interruption in the narrative of profit margin expansion.

The following is a detailed interpretation of this quarter's financial report:

1. GMV & GPV growth continues to accelerate and remains strong

The most critical operational metric—this quarter Shopify facilitated a total GMV of $94.5 billion, a year-on-year increase of 25.7%, accelerating by about 1.7 percentage points compared to the previous quarter, and exceeding the consensus expectation of about 24% growth from sell-side analysts. The core metric has shown accelerated GMV growth for two consecutive quarters, reflecting Shopify's current strong growth momentum.

However, Shopify's high valuation during this period implies higher market expectations. It is reported that buyers' expectations for this quarter's GMV growth were actually between 25% and 26%, so this quarter's performance is more in line with or slightly under the expectations of more optimistic investors.

The company has not disclosed the total GPV to date; we speculate that this is due to the impact of PayPal's confirmation of the change in criteria: from originally being regarded as a third-party payment channel to being regarded as a first-party channel. Therefore, payments completed by merchants through PayPal on Shopify will be fully accounted for in GPV and merchant service revenue metrics. It is estimated that this change in criteria has a positive impact of about 300 basis points on the ratio of GPV to GMV.

Based on the annual data disclosed by the company, it can be inferred that **the GPV for this quarter is $60.7 billion, a year-on-year increase of 34.7%, which is 3.3% higher than market expectations. The penetration rate of Shopify Payments (i.e., GPV / GMV) reached 64.3%, an increase of about 280 basis points quarter-on-quarter, generally in line with the above calculations **

II. MRR expectations weaken unexpectedly, subscription revenue growth may decline next quarter?

However, the MRR (Monthly Recurring Revenue) indicator reflecting the subscription business this quarter is $178 million per month, lower than the market expectation of $182 million. It has a year-on-year growth of 19.5%, showing a significant slowdown of 4.6 percentage points compared to the previous quarter. The performance is significantly weaker than expected, but high-frequency MAU data shows that the MAU growth rate of Shopify Store App (online) and Shopify POS App (offline) has noticeably slowed down in 4Q. Some investment banks have already warned of the risk that subscription revenue may fall below expectations before the earnings report. Coupled with the gross margin of subscription revenue also falling short of expectations, we speculate that the average subscription price may not be as high as anticipated, but the specific reasons need to await guidance from management.

III. PayPal cooperation is beneficial, payment revenue accelerates growth

In terms of revenue, merchant services revenue this quarter is $2.15 billion, with a year-on-year growth rate jumping to 31.2%, significantly outperforming the market expectation of 27.4%. However, as mentioned above, in addition to strong GMV growth, a considerable part of this is due to the impact of changes in revenue recognition criteria from the PayPal channel. Correspondingly, this quarter the monetization rate of merchant services (the proportion of GMV) increased by 11 basis points year-on-year. This continues the trend of recovery in the monetization rate since last quarter.

Subscription service revenue is $670 million, a year-on-year increase of 26.9%, higher than the market expectation of 24.2%. Unlike the MRR indicator, the growth of subscription service revenue did not slow down quarter-on-quarter. However, since MRR is a relatively leading indicator, subscription revenue may experience a slowdown in growth next quarter.

Overall, thanks to the significant acceleration in merchant services revenue due to favorable changes in criteria, and the subscription revenue that has not yet shown a slowdown, **Shopify's total revenue this quarter reached $2.16 billion, better than the expected $2.12 billion. The actual revenue growth rate reached 26.4%, a significant increase compared to the growth rate of less than 21% in the previous quarter **

IV. Both major businesses have expected and unexpected gross margin declines

From the perspective of gross profit, the aforementioned conversion of PayPal channel revenue from net to gross basis is a negative for gross margin. Therefore, the gross margin of the merchant services business decreased by about 1 percentage point year-on-year this quarter, which is consistent with market expectations and does not contain any unexpected bad news.

However, the gross margin of subscription service revenue also decreased by about 2 percentage points year-on-year, which is completely unexpected by the market. Combined with the MRR, which is also lower than expected, we suspect that the company may have provided some price discounts to users, but the actual situation needs to be clarified by management.

Due to the expected and unexpected gross margin declines in both businesses, Shopify's overall gross margin also contracted by about 90 basis points year-on-year, which is about 50 basis points lower than market expectations. This led to a total gross profit growth of 25% year-on-year to $1.35 billion, lagging behind the 31% revenue growth.

V. Expense growth is lower than revenue, and the trend of "passive" cost control and efficiency improvement continues

From the expense perspective, this quarter Shopify's total operating expense was approximately $890 million, accounting for about 32% of revenue, which is at the lower end of the company's guidance of 32%-33%, and is generally consistent with market expectations.

Compared to last year, the expense ratio decreased by about 4 percentage points year-on-year, with marketing expenses contributing the most significantly, growing only 9.8% year-on-year, far below the revenue growth rate. This alone saved 2.4 percentage points in profit margin year-on-year. Research and development expenses and administrative expenses also grew only 12%-13%, which is significantly lower than revenue growth. It can be seen that under strong growth, the company's expenses are being passively diluted overall.

VI. Increased acceleration, reduced expenses, and profits soar

Due to the continued strong growth of core underlying indicators GMV & GPV (although MRR has weakened, it has not yet reflected in revenue), and the ongoing "passive" cost control, although gross margins have unexpectedly declined, overall Shopify's profits are still improving. This quarter, the core operating profit margin (excluding only the usual three expenses, not deducting loan losses, etc.) increased by 3.6 percentage points year-on-year to 19.2%, continuing to set a historical high, and also exceeding the market expectation of 17.9%. Actual core operating profit of $540 million, higher than the market expectation of $490 million.

The company's more focused free cash profit reached $610 million this quarter, also exceeding market expectations by about 7%. The cash profit margin was 21.7%, better than the company's guidance that profit margins would remain flat year-on-year (about 20.8%).